Volcker: Fed Will 'Fall Short' by Being Asked to Do Too Much

Former Federal Reserve Chairman Paul Volcker said the central bank will probably “fall short” by being asked to do too much.

“It’s fashionable to talk about a dual mandate, that policy should somehow be directed toward two objectives, of price stability and full employment,” Volcker told the Economic Club of New York.

“Fashionable or not, I find that mandate both operationally confusing and ultimately illusory.”

With unemployment lingering at 7.5 percent — still higher than before the last recession — the Federal Open Market Committee announced May 1 that it will increase or decrease the pace of its monthly bond purchases in response to changes in inflation and the labor market.

The policy makers agreed to maintain monthly buying of $40 billion in mortgage securities and $45 billion of U.S. Treasuries in a bid to boost employment.

“Asked to do too much, for instance to accommodate misguided fiscal policies, to deal with structural imbalances, to square continuously the hypothetical circles of stability, growth and full employment, then it will inevitably fall short,” Volcker said. Those efforts cause it to lose “sight of its basic responsibility for price stability, a matter that is within the range of its influence.”

Volcker, 85, served as chairman of the Fed from 1979 to 1987. He helped cut the unemployment rate to an eight-year low of 5.7 percent in 1987, his last year as Fed chairman, after reversing interest-rate increases that brought inflation down from as high as 15 percent.

Rewriting Regulations

He has provided advice to the federal government on economic issues as well as the rewriting of regulations for financial institutions.

The law enacting those regulations included the so-called Volcker rule, which would ban proprietary trading at banks and restrict their investments in private- equity and hedge funds.

“The Federal Reserve, any central bank, should not be asked to do too much to undertake responsibilities that it cannot responsibly meet with its appropriately limited powers,” Volcker said. He said a central bank’s basic responsibility is for a “stable currency.”

“Credibility is an enormous asset,” Volcker said. “Once earned, it must not be frittered away by yielding to the notion that a little inflation right now is a good a thing, a good thing to release animal spirits and to pep up investment.”

“The implicit assumption behind that siren call must be that the inflation rate can be manipulated to reach economic objectives,” according to Volcker.

“Up today, maybe a little more tomorrow and then pulled back on command. Good luck in that. All experience demonstrates that inflation, when fairly and deliberately started, is hard to control and reverse.”